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RBI Panel on Economic Capital Framework

Topics covered:

Government policies and interventions for development in various sectors and issues arising out of their design and implementation.

Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment.

Inclusive growth and issues arising from it.

 

RBI Panel on Economic Capital Framework

 

What to study?

For Prelims: Meaning of Economic Capital Framework, arrangements for sharing of surplus between RBI and the government.

For Mains: Issues over RBI autonomy, need for transfer of surplus and the need for review of existing arrangements.

 

Context: The Reserve Bank of India (RBI)-appointed committee to review the economic capital framework of the central bank has failed to arrive at a consensus during a recently held meeting leading to a delay in finalising its report.

 

Difference of opinion:

The main difference of opinion has arisen between the panel members and the government’s representative on the panel over the transfer of the RBI’s ‘excess’ capital reserves.

While most panel members were in favour of a phased transfer of the RBI’s capital reserves to the government over the years, the government’s view is for a one-time transfer.

 

Background:

RBI had constituted a panel on economic capital framework. It was headed by Ex-RBI governor Bimal Jalan.

The expert panel on RBI’s economic capital framework was formed to address the issue of RBI reserves—one of the sticking points between the central bank and the government.

 

What’s the isssue?

The government has been insisting that the central bank hand over its surplus reserves amid a shortfall in revenue collections. Access to the funds will allow the government to meet deficit targets, infuse capital into weak banks to boost lending and fund welfare programmes.

 

What is economic capital framework?

Economic capital framework refers to the risk capital required by the central bank while taking into account different risks. The economic capital framework reflects the capital that an institution requires or needs to hold as a counter against unforeseen risks or events or losses in the future.

 

Why it needs a fix?

Existing economic capital framework which governs the RBI’s capital requirements and terms for the transfer of its surplus to the government is based on a conservative assessment of risk by the central bank and that a review of the framework would result in excess capital being freed, which the RBI can then share with the government.

The government believes that RBI is sitting on much higher reserves than it actually needs to tide over financial emergencies that India may face.

Some central banks around the world (like US and UK) keep 13% to 14% of their assets as a reserve compared to RBI’s 27% and some (like Russia) more than that.

Economists in the past have argued for RBI releasing ‘extra’ capital that can be put to productive use by the government. The Malegam Committee estimated the excess (in 2013) at Rs 1.49 lakh crore.

 

What is the nature of the arrangement between the government and RBI on the transfer of surplus or profits?

Although RBI was promoted as a private shareholders’ bank in 1935 with a paid up capital of Rs 5 crore, the government nationalised RBI in January 1949, making the sovereign its “owner”. What the central bank does, therefore, is transfer the “surplus” — that is, the excess of income over expenditure — to the government, in accordance with Section 47 (Allocation of Surplus Profits) of the Reserve Bank of India Act, 1934.

 

Does the RBI pay tax on these earnings or profits?

No. Its statute provides exemption from paying income-tax or any other tax, including wealth tax.

 

 

Why RBI needs excess reserves?

The RBI needs adequate capital reserves for monetary policy operations, currency fluctuations, possible fall in value of bonds, sterilisation costs related to open-market operations, credit risks arising from the lender of last resort function and other risks from unexpected increase in its expenditure.

The RBI has maintained the view that it needs to have a stronger balance sheet to deal with a possible crisis and external shocks.

 

Sources: the Hindu.